Nature and Scope
The scope of this post is limited to analysing changes from a circular issued by Reserve Bank of India (“RBI”) circular on “Investment by Foreign Portfolio Investors (FPI) in Debt – Review” circular no. RBI/2017-18/168 dated April 27, 2018 (access here) (“April Circular”) to another RBI circular on “Investment by Foreign Portfolio Investors (FPI) in Debt – Review” circular no. RBI/2017-18/199 dated June 15, 2018 (access here) (“June Circular”).
Background
FPI has been defined under Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017 as “any investment made by a person resident outside India through capital instruments where such investment is less than 10 percent of the post issue paid-up share capital on a fully diluted basis of a listed Indian company or less than 10 percent of the paid up value of each series of capital instruments of a listed Indian company”. FPI was introduced in India to strategize the debt market. While under FDI route, investment could only be made in equity or Compulsorily Convertible Debentures (“CCD”) like instruments, FPI created a new avenue for investment in debts. It came with benefits like ease of repatriation, tax optimisation, lesser restrictions compared to options like External Commercial Borrowings (“ECBs”). However, through the April Circular, RBI created certain restrictions on FPIs in terms of diversification and concentration norms in terms of corporate bonds and government securities.
Overview of April Circular
April circular brought in changes mainly in the following terms, in the framework of FPIs:
Maturity
Diversification norms
Discontinuance of auction
Maturity
RBI has provided with relaxation in terms of maturity period. While previously the residual maturity period was 3 years for both Government Securities (“G-Sec”) and corporate bonds, the maturity period for G-Sec was withdrawn and for corporate bonds, it was fixed at 1 year or above. However, the withdrawal of maturity period for G-sec comes with a requirement that all the investment with a maturity period under 1 year should not exceed 20% of total investment in that category. This requirement was later made applicable to corporate bonds as well via a circular issued on May 1, 2018 (access here) (“May Circular”)
Diversification
The requirement of RBI is that more FPIs or related FPIs cannot invest more than 50% in any corporate bond issue. This can be interpreted to mean that every corporate bond issuance shall have two or more subscribers provided that none of them hold more than 50% of the issuance. It is further clarified by RBI that if any investment has been made in the past exceeding 50%, it does not have to be disinvested. However, no further investment can be made with respect to that issuance even if a commitment to that effect has been made.
It is to be noted that definition of “related FPI” was provided separately in the May Circular. It is defined as “all FPIs registered by a non-resident entity” The definition under SEBI (FPI) Regulations seems to be on a similar line where the test of ultimate beneficial owners is applied. The illustration in May Circular clarifies the same through an illustration that for instance if a non-resident entity has set up five funds, then while determining concentration norms etc., a total investment made my all five funds would be considered.
Further, the RBI requires that FPI should not have an exposure more than that of 20% of corporate bond portfolio to a single corporate entity. This said to have included entities related to the corporate. May Circular clarified that the “entities related” shall have the same meaning as of “related party” under 2(76) of Companies Act, 2013 (“CA, 2013”). It is pertinent to note that this requirement has not been made applicable to “related FPIs”. SEBI seems have concurred pursuant to its circular “Review of Investment by Foreign Portfolio Investors (FPI) in Debt” circular no. IMD/FPIC/CIR/P/2018/101 dated June 15, 2018 (access here) (“SEBI Circular”) which is in line with June Circular.
Discontinuation of Auction
Vide the April Circular, RBI discontinued auction mechanism with effect from June 1, 2018. This mechanism was utilised for allocating the G-Sec which were remaining after FPIs had invested upto 90%.. However, now the process will be monitored online by Clearing Corporation of India Ltd. (“CCIL”).
Newly Registered FPIs
As per the April circulars, all the newly registered FPIs were required to comply with the requirement of within 3 months. May Circular clarifies that newly registered FPIs would mean any FPI registered after April 27, 2018. This relaxation is on the grounds that if the relaxation was not granted, they would be in violation on the first day. However, this wasn’t speculated to be sufficient.
Modifications in the June Circular and SEBI Circular
June Circular has been modified on the following points:
Short Term Investments
Introduction of “end-of-day” basis
Security Receipts and Multilateral Financial Institutions
Clarification on pipeline investment
Timeframe for newly registered FPIs
Consequences of Default
Short Term Investment
The term “short term investment” has been introduced in the June circular and it has been defined in 4(a) (i) to mean investments with a residual maturity up to one year. However, it is subject to the condition that it should not exceed 20% of the total investment.
Introduction of “end-of-day” basis
The requirement of 20% on short term investments would apply on end-of-day basis. End of day (“EOD”) as per Bombay Stock Exchange is 6.00 PM[1] and as per NSE it is 6.15 PM.[2] There remains an ambiguity as to what constitutes an EOD as the RBI Master Direction on “Money Market Instruments: Call/Notice Money Market, Commercial Paper, Certificates of Deposit and Non-Convertible Debentures” Master Direction No. RBI/FMRD/2016-17/32 dated July 7, 2016 refers to dealing session to end at 5.00 PM each business day. For RTGS system at RBI, EOD has been defined on the weekdays to be 7.30 PM or on the weekend 3.30 PM.[3]
Security Receipts and Multilateral Financial Institutions
The June circular defines two terms Security Receipts (“SRs”) and Multilateral Financial Institution (“MFIs”). MFIs are defined to mean FPIs which are MFIs and Government of India is a member. Application of minimum residual maturity period specifically excludes SRs. Further, the investor wise limits discussed above under “diversification” above, would not be applicable to MFIs and SRs.
Pipeline Investments
It has been clarified in the June Circular that the investments which had not materialised, but were under process as on April 27, 2018, they shall be exempt from the requirement of not exceeding 50% of any issue of corporate bond and requirement of not exceeding 20% investment in a single corporate entity including its related entity. However, this is subject to the satisfaction of the custodian of following conditions:
Terms with respect to price, tenor and the amount of investment has been agreed upon;
The actual invest would initiate before December 31, 2018; and
All the other guidelines, prior to April 27, 2018, with respect to FPIs have been complied with.
Timeframe for newly registered FPIs
In the April Circular the time given to newly registered FPIs was 6 months to comply with the terms of this circular. However, relaxation has been provided through the June Circular wherein the timeframe given to newly registered FPIs is 6 months or till March 31, 2019 whichever is later.
Consequences of Default
Online monitoring by CCIL was said to have replaced the auctioning or bidding process for G-Secs and State Development Loan (“SDL”) categories. However, in the June Circular, it has been specified that any transaction breaching the conditions in this circular would not be accepted on the online platform and in case, a transaction does it place, the same would be reversed. While the authority for monitoring the transactions for G-Secs and SDL is conferred on CCIL, no such special authority has been specified for corporate bonds or action to be taken in case of breach of its conditions or guidelines for monitoring the same.
Comments